Valgreen

3/17/14

Banks – Bail in & Bail out

Carsten Valgreen GIC March 2013 Jason.Benderly@agmresearch.com (970) 476-­‐7110, Carsten.Valgreen@agmresearch.com +45 61 66 71 83 Mary.Allyn@agmresearch.com (970) 926-­‐0220, Niels.Bjorn@agmresearch.com + 45 29 89 58 04 www.AppliedGlobalMacroResearch.com Copenhagen Vail

1 3/17/14

The Long run View – Don’t be Short Banks

2 3/17/14

The Bank Carry Game What a Bank is

• • • •

A Long only Illiquid Credit Por\olio Leverages approximately 10 _mes Financed by Government guaranteed deposits ... … or the interbank market which is guaranteed by the Central Bank • Pretending to be a AAA credit 3 3/17/14

How Would You expect the payout of this Carry Strategy to US Banks, Actual return on equity (Datastream) look?

20

20

15

15

10

10 US Banks, return on equity (FDIC)

5

5

0

0

-­‐5

-­‐5

-­‐10

-­‐10

-­‐15

-­‐15

-­‐20

-­‐20

84

86

88

90

92

94

96

98

00

02

04

06

08

10

12

14

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When and why do you lose money on Banks?

50

50

% of financial corporation value added (to scaled GDP before 1950)

40

40 Commercial Banks, Net interest income

30

30

20

20

10

10

Commercial Banks, Net non-­‐interest income

0 -­‐10

0 -­‐10

Commercial Banks, Net losses

-­‐20

-­‐20

-­‐30

-­‐30 35

40

45

50

55

60

65

70

75

80

85

90

95

00

05

10

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It’s the Credit losses that mafer – nothing else 30 25

30

% of financial value added (GDP before 1950)

20

25 20

US Commercial Banks, Net income before loss provisions

15

15

10

10

5

5

US Commercial Banks, net income

0

0

-­‐5

-­‐5

-­‐10

-­‐10

-­‐15

-­‐15

-­‐20

-­‐20 35

40

45

50

55

60

65

70

75

80

85

90

95

00

05

10

Banking crisis temporarily boosts net pre-­‐loss interest income because of higher credit spreads

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Four Myths About Banks 1. Banks can’t make money when interest rates are low 2. Banks can’t make money when the yield curve is flat 3. Banks can’t make money when capital ra_os are high 4. Banks can’ make money when regula_on is tougher 5. Banks (and credit) is causing economic growth

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Capital Ra_os are very high

… and – no – high capital ra_os don’t prevent banking crisis 14

14

%

13

13

12

12

11 10

11 US Banks Total Equity capital ratio (FDIC)

10

9

9

8

8

7

7

6

6

5

US Banks Tier 1 Equity capital ratio (FDIC)

5

1935 1940 1945 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010

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And – yep – Credit standards are being competed _ghter again even in Europe – as always

Euro area

US

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Can this go on forever?

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Won’t deleveraging kill growth in banking forever?

190

percent

percent

180

180

total private nonfinancial debt as a percent of GDP

170

190

170

160

160

150

150

140

140

130

130

120

120

110

110

100

100

90

90

80

1970

1975

1980

1985

1990

1995

2000

2005

2010

80

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Why Debt – and bank revenue -­‐ lags Nominal Growth 7

7

$ trillions

$ trillions

current quarter's level of credit generating spe nding v e rsus mov ing av e rage

6

6

5

5

4

4

3

3

2

2

current quarter moving average

1

1

20

% ch (SAAR)

% ch (SAAR)

18 0

1970

1975

1980

1985

1990

1995

2000

2005

2010

0

20 18

total private nonfinancial (PNF) debt (1-qtr growth) versus credit generating spending (current qtr less moving average)

16 14

16 14

12

12

10

10

8

8

6

6

4

4

2

2

0

0

-2

-2

PNF debt growth credit generating spending

-4 1970

1975

1980

1985

1990

1995

2000

-4

2005

2010

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Dont worry – debt will be back

13 3/17/14

Next US Banking Cycle is coming up

14 3/17/14

And you can s_ll catch the train

Bank Inves_ng for Simple Macro Investors Rule 1: Never buy banks at more than 1.5 _mes book Rule 2: Never buy banks when home prices are high and unemployment low Rule 3: Buy banks during recession/banking crisis when sector P/B<0.75

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